Is Private Debt the holy grail of investments?

Is Private Debt the holy grail of investments?

The great challenge of being a professional investor is nothing new: protecting your capital while generating returns to make it grow simultaneously.

The great challenge of being a professional investor is nothing new: protecting your capital while generating returns to make it grow simultaneously. Based on the belief that there is an inverse risk-return equation, that is, to have more return, we need to take more risk, and the more risk we take the greater the likelihood of losing capital, investors stand between the cross and the sword.

Therefore, the holy grail for investors would be to find a way to invest that breaks the “greater the risk, greater the return, but also greater the probability of patrimonial loss” paradigm. Thus, it is intriguing to read about the private debt investment segment.

Globally, the volume of assets under management classified as private debt grew from US$205 billion in 2007 to US$700 billion in October 2018. The expectation for 2023 is that the volume of resources allocated globally in private debt should double, reaching level of US$1.4 trillion, according to a study developed by Preqin, an adviser on alternative investments.

Of course, any investment segment that is growing at these rates deserves more attention.

We see that, typically, investment funds that fall into the segment called private debt, in developed markets, allocate their funds in the following types of credit:

Direct financing to small and medium-sized enterprises (SMEs);

Purchase of consumer credit portfolios or portfolios related to the financing of real estate purchases;

“Mezzanine” financing, in which the creditor can transform its debt into the company’s capital if it does not reach pre-established objectives;

Financing the restructuring of companies with distressed debt, in addition to,

Other non-listed structured loans;

In the international market, the three main drivers for growth in the private debt segment were:

The significant reduction of the volume of credit granted by the traditional financial system that followed the global crisis of 2007/2008;

The search for higher returns over a long period of reduced interest rate and,

The ability of private debt to generate attractive returns, often similar to returns offered by variable income investments, with low correlation with traditional asset classes and attractive risk / return ratio.

The SME segment, one of the sources of opportunities for private debt funds around the world, has credit demand well above the amount of credit that traditional financial institutions are willing to offer. This factor is even more relevant when we introduce the term of the financing to SMEs; long-term debt to the segment is even more scarce;

This points to a supply-demand imbalance, which could ultimately mean that there are asset classes, such as this one, that could defy the old investors’ paradigm. Digging deeper into the numbers, there has been an amazing consistency in private debt fund returns, with over 92% of investors indicating that their private debt investments have either lived up to or exceeded their expectations over the past three years, according to the Prequin Private Debt Investor Outlook H12018.

Furthermore, considering the predictable nature of a well-underwritten, well diversified credit portfolio, perhaps private debt represents a new investor paradigm, where there are low-volatility, consistent and uncorrelated returns to be had.